Activist hedge-fund chiefs, and their many stripes

Some use caustic attacks, others quiet collaboration, to revamp boardrooms

By

AlistairBarr

LauraMandaro

Correction: A previous version misstated Third Point Offshore fund's performance this year.

SAN FRANCISCO (MarketWatch) -- Activist hedge funds have become a powerful force shaking up the corporate landscape, pressing companies to change strategies, ousting their executives and even acquiring whole businesses.

But not all activists are alike. With annual returns falling from their stellar levels of the past as the niche area gets more crowded, their differing methods illustrate what distinguishes one activist fund group from another. See related story.

Some get deeply involved in the companies they invest in, taking board seats and even running businesses themselves. Others are more traditional value investors who occasionally have a hand in boardroom machinations.

A few of them openly attack executives to stir things up, while others prefer to work quietly behind the scenes, sometimes in collaboration with current management.

Other funds, such as Chapman Capital, Pirate Capital and Jana Partners, also use confrontational tactics, earning activists a fearsome reputation as swashbuckling investors who can end an executive's career quickly if they don't get what they want.

"I don't have a problem with managers being disagreeable if they know what they're doing, but just writing a letter for the purpose of scaring a company into selling itself doesn't add value," said Bill Ferrell, president of hedge-fund investment firm Ferrell Capital.

Ferrell declined to comment on specific hedge funds, but he added, "For activists to be relevant to a company and its management, they have to be competent and sensitive to stakeholders including customers, employees and vendors."

'It is time for you to step down so that you can do what you do best: retreat to your waterfront mansion in the Hamptons.'
Letter to a CEO from activist investor Dan Loeb

One of the most outspoken activists is Dan Loeb, head of New York-based Third Point LLC, who has made a name for himself by publicly maligning executives of companies he targets for shakeups.

Loeb is best known for writing caustic, public letters criticizing the management and board of companies he's invested in.

If Third Point were to have a Web site, Loeb mused in a letter last year to directors of Salton Inc.
SFP, +1.36%
"we would likely depict a well-worn boot colliding with the backside of an incompetent manager."

Earlier this year, while berating directors of Nabi Biopharmaceuticals
NABI
for not responding to his previous letters, Loeb continued the theme.

"You hide your heads in the nearest warm aperture in an apparent ostrich defense and ignore your shareholders," he wrote.

In a letter calling for the ouster of Irik Sevin, chief executive of Star Gas Partners
SGU, -0.11%
Loeb wrote: "It is time for you to step down from your role as CEO and director so that you can do what you do best: retreat to your waterfront mansion in the Hamptons where you can play tennis and hobnob with your fellow socialites."

Loeb didn't respond to an interview request.

In addition to pushing for management changes, Loeb often demands that executives put their companies up for sale and sometimes mentions in letters that other companies or private-equity firms are interested in acquiring all or part of the businesses.

Earlier this year, Loeb called on Nabi to consider being sold. See full story.

In April, he told plastic-film manufacturer AEP Industries
AEPI
to buy back 2 million shares or sell to the highest bidder. See full story.

Not surprisingly, his approach has some fans, but also has stirred controversy.

"There's a time and place for everything and in some circumstances that's a very appropriate approach," said Keith Rosenbloom, managing member of Care Capital Group, a $500 million fund of hedge funds. "But there are also circumstances where it's not. Too many scathing letters and you may lose effectiveness."

One Third Point investor, who declined to be identified, said Loeb's letter writing helps grab the attention of management. Third Point, the investor said, probably becomes active in less than a third of investments, generating the rest of its returns from value-focused stock picking.

And Third Point has been very successful doing that, producing annual returns that have averaged roughly 22% since the firm started in November 1996.

Still, this year, Loeb has lagged his historical performance. The $2.3 billion Third Point Offshore fund was up 5.1% this year through the end of August, according to investors and banks tracking fund returns.

Shares of Massey Energy
MEE, +0.00%
one of Third Point's biggest holdings, have lost roughly one-third of their value this year, even though Loeb gained seats on the coal company's board in July.

Since Loeb first wrote his critical letters to Salton and Star Gas in February 2005, shares of those companies have lost roughly 20% and 35% respectively.

Pirate booty

Pirate Capital also has an activist streak and a penchant for corporate confrontation.

Thomas Hudson, a former Goldman Sachs trader, started the Norwalk, Conn.-based firm in 2002 with $2 million. The firm now manages more than $1.5 billion in assets and its Jolly Roger Offshore fund has generated annual returns of 25%.

Pirate began buying shares of Intrawest in May 2005 when they traded below $20 and amassed an 18% stake. In February, after Intrawest hired Goldman to consider strategic alternatives, Pirate wrote an open letter to its board urging them to sell the entire company.

Last month, Pirate got its booty. Another private investment group agreed to buy Intrawest for roughly $35 a share, or roughly $3 billion. See full story.

Pirate is hounding other companies with the same message.

In August, the firm told security-services company Brinks Co.
BCO, +2.37%
that it should put itself up for sale. Pirate owns almost 9% of Brinks. In June, Pirate asked Mirant Corp.
MIR, +0.00%
do the same. See full story.

Mirant shares are up almost 8% this year, and Brinks is up over 17%.

However, the torrid pace of Pirate's growth has sparked concern among some investors.

Two fund investors who asked not to be named said the firm has hired a big marketing team to try to attract new clients and may be focusing too much on accumulating assets rather than generating returns.

When asked about steeply rising assets at a hedge fund conference in San Francisco earlier this year, Kerry Baldwin, director of sales at Pirate, said the firm benefits from having more money to invest because that helps it take bigger stakes in larger companies -- increasing its chances of influencing management.

To be sure, its victory in the Intrawest acquisition contrast with some significant setbacks of late.

The firm's offshore fund was up a little over 7% through the end of August. Between April and July, the fund lost almost 10%. It gained 19% in 2005, 29% in 2004 and 39% in 2003.

In April and May, Pirate built a 5.3% stake in OSI Restaurant Partners Inc.
OSI, +1.38%
the operator of Outback Steakhouse restaurants, buying shares at $39 to just over $42.

In June, Hudson wrote an open letter to OSI Chairman Chris Sullivan suggesting a spinoff of its Carrabba's, Bonefish Grill and Fleming's businesses. Hudson also said the company should stop expanding its Outback chain in the U.S. until profitability improved at current restaurants.

Since the beginning of April, OSI stock has dropped more than 20%.

Pirate has now sold its entire position and in a letter to investors, Hudson reportedly said the firm's performance had been dented by its inability to spur management action at companies, including OSI.

The firm also has a debacle on its hands following its drive to win three seats on the board of James River Coal Co.
JRCC
earlier this year. It successfully got the company to hire Morgan Stanley to help it explore strategic alternatives, including a sale.

But despite notching some tactical victories, Pirate has seen James River shares lose more than 60% of their value since the firm first disclosed its investment in the company in November 2005.

Feeding, fighting the barbarians

Jana Partners, an activist hedge fund run by Barry Rosenstein, has a love-hate relationship with private-equity firms.

In 1990, Choctaw Securities, an investment group run by Rosenstein and Perry Sutherland, tried to acquire Justin Industries for more than $150 million in a leveraged buyout. Justin, a maker of bricks and cowboy boots, managed to fend off the bid, in part by taking on more debt to buy another business.

A decade later, Justin agreed to be acquired by Warren Buffett's Berkshire Hathaway for roughly $600 million in cash.

Rosenstein shares Buffett's focus on undervalued companies, but they differ greatly in how they invest and generate returns.

Buffett shuns debt. But Rosenstein was a protégé of Asher Edelman, a 1980's leveraged buyout specialist, and ran his own private-equity firm Sagaponack Partners before starting Jana. He was also an investment banker at Merrill Lynch before working for Edelman.

In an interview with MarketWatch last year, Rosenstein said he saw private-equity firms as a way to realize value from an investment, by encouraging companies to sell themselves in leveraged buyouts. See full story.

However, Jana has also clashed with private-equity firms that recently offered to buy tire maker Titan International
TWI, +0.34%
for less than Rosenstein thought it was worth.

"The question in each case is whether an offer fairly values a company," Rosenstein said. "Often prices paid by private-equity buyers don't reflect the value of cost-cutting, financial restructuring or other value enhancements that management could and should be delivering for their shareholders rather than private-equity buyers."

Most of Jana's investments are passive and focus on situations where there are already catalysts that could unlock value. However, in about 15% of cases, Jana tries to engineer an event itself through activism.

Jana has generated annual returns of roughly 23% since the firm started in early 2001.

The firm joined Icahn in his battle with TimeWarner last year and was involved in a successful assault by activist hedge funds on German stock exchange operator Deutsche Boerse in 2004.

The firm's biggest coup was perhaps its investment in oil and gas exploration company Kerr-McGee Corp.

Jana and Icahn took big stakes in the company and persuaded it to buy back roughly $4 billion of its shares last year. In June, the company agreed to sell itself to Anadarko Petroleum Corp.
APC, -0.74%
for more than $16 billion, or $70.50 a share. See full story.

The offer price was more than double where Kerr-McGee's shares traded at the beginning of 2005.

Despite the Kerr-McGee boost, Jana hasn't performed as well recently. The firm's $3 billion offshore fund was up 8.4% through the end of August. Last year, the fund returned 11.4%. In 2004 and 2003, the fund gained 25% and 46% respectively.

TimeWarner shares, a big Jana holding, are down almost 5% so far this year. The firm's stake in Six Flags has also weighed on performance.

The hands-on activist

Jeffrey Ubben, manager of San Francisco-based ValueAct Capital Management, sees himself as the antidote to the common complaint that activist hedge funds are just out to make a quick profit by bullying companies into repurchasing shares or selling themselves.

The firm, which oversees more than $3 billion, typically invests in undervalued companies with strong business models that are out of favor with investors or struggling with change or crisis.

Ubben, a former fund manager from mutual fund giant Fidelity Investments, usually tries to work with company executives to improve operations. However, ValueAct has also taken more confrontational positions in some of the companies its invested in during recent years.

But what's striking about Ubben is his willingness to take part in managing the companies he invests in, taking board seats for long periods or even bidding to acquire whole companies.

That puts Ubben in the same league with other hands-on activists such as Barington Capital, run by James Mitarotonda, and Warren Lichtenstein's Steel Partners.

"Activist investors are now often generalized as quick-buck artists," he wrote in a recent editorial in Alpha magazine, a hedge-fund industry publication. "It is incumbent upon today's directors -- as well as the shareholders they serve -- to understand the distinction between long-term value creators and short-term saber rattlers."

"An activist must be prepared to step into the fray, lead a proxy slate of new directors or pay a premium for control," Ubben added.

It was Ubben who stepped into the management hot seat in June 2003 when he became chairman of Martha Stewart Living Omnimedia
MSO, +0.00%
He took on the role just as founder Martha Stewart resigned after being indicted on criminal charges related to her sale of shares in biotech firm ImClone Systems
IMCL, +6.11%

ValueAct first invested in Martha Stewart Living in January 2002 and by March 2003 owned 22% of the company, making it the largest shareholder after Stewart herself.

Martha Stewart Living shares had slumped from a high of almost $40 soon after the company's initial public offering in late 1999 to below $7 in October 2002 on concern that Stewart's tarnished image might ruin the media company's business.

Over more than a year, Ubben helped pick a new chairman and a new chief executive for the company and installed a new board of directors. By the time Stewart began her five-month prison sentence in October 2004, Ubben had left the company in the hands of its new management team, but ValueAct remained its main outside investor.

As the stock market's focus began to shift from Stewart's troubles to the potential benefits of her release and return to the company, the stock surged.

As the shares rallied in November 2004, Ubben sold about half ValueAct's stake for just less than $40 million. In late February and early March 2005, Ubben sold another chunk of the stock for more than $32.50 each, leaving ValueAct with a stake of less than 1%.

A major theme at ValueAct is identifying companies that performed well under a talented founder, but have ended up outgrowing their original leader, Ubben said in an interview earlier this year. "It's not good for a founder to still be in the top slot after 20 or 30 years," Ubben said. "My whole job with Martha Stewart was to transition the company from its founder roots to professional management."

Ubben has been trying, with some success, to engineer similar changes at Acxiom Corp.
ACXM, +1.45%
a database-software company.

In April, ValueAct started a proxy fight with Acxiom and last month, the company announced an agreement with Ubben giving his firm board seats. See full story.

But the victory was limited. Earlier this year, Ubben said he planned to replace Acxiom Chairman Charles Morgan, who has run the company for more than 30 years. But in its

August pact, ValueAct agreed to vote for Morgan's re-election.

"We're happy to have Charles stay involved in some capacity, but it's a founder-run company and it has all the problems of a founder-run culture," Ubben said in April. "The business has outgrown the founder and it's not taking advantage of opportunities in the marketplace."

ValueAct became an Acxiom shareholder in 2003 and began trying to encourage the company to develop shareholder-friendly initiatives such as increasing cash flow and improving margins. The firm also criticized Acxiom's board for not being independent enough from management.

When the company didn't respond the way ValueAct wanted, Ubben offered to buy the whole business for $23 a share in cash. He raised the offer to $25 a share in December, valuing Acxiom at more than $2 billion.

Similar to his strategy with Martha Stewart Living, Ubben lined up executives to run Acxiom, but this time as a private firm.

The reluctant activist

At the other extreme of hedge fund activism are huge firms like Atticus Capital, that don't even want to be associated with the strategy.

"It's fairer to characterize us as re-activists rather than activists," Rob Coburn, a spokesman for the $12 billion New York-based firm, said. "We don't go into positions with the expectation that we'll have to take any public stance."

The firm has become active in only a handful of cases in the past, where it believed shareholders' interests were at risk, he added.

And yet, Atticus and its 41-year-old founder, Timothy Barakett, have been at the center of some of the highest-profile activist coups of recent years, helping to oust powerful executives and influencing the outcome of massive acquisitions.

Last year, Atticus joined Chris Hohn's Children's Investment Fund, to criticize a planned acquisition of the London Stock Exchange (LSE) by German stock market operator Deutsche Boerse (581005). See full story.

The hedge funds helped oust Deutsche Boerse Chief Executive Werner Seifert and persuaded the company to ditch its takeover attempt and return more than 1 billion euros of extra cash to shareholders.

In addition to being an influential Deutsche Boerse investor, Atticus is the largest shareholder in NYSE Group
NYX, +0.20%
and owns more than 10 million shares of European stock exchange operator Euronext (005777).

That's made Barakett a lynchpin during a period of unprecedented consolidation among the world's largest exchanges.

After initially calling for a merger between Euronext and Deutsche Boerse, Atticus signaled in May that it was willing to consider a deal with NYSE Group. By June, the NYSE and Euronext had unveiled a $20 billion merger agreement. See full story.

Barakett started Atticus in 1995 as a merger arbitrage hedge fund, betting on the outcome of deals. Before that, the Harvard Business School graduate worked at Junction Advisors, another arbitrage hedge fund, and also spent time in private equity.

Merger arbitrage hedge funds usually wager on announced transactions, buying shares of target companies and betting against the stock of acquiring firms. As a deal nears completion, the share prices of the two firms usually converge, generating returns for managers.

But Atticus' approach to the strategy has evolved to a point where the firm invests in deals based on how Barakett and colleagues think combined businesses will perform in future.

The firm also allows itself the flexibility to either hedge its position or be un-hedged, depending on its view of how successful transactions might end up being.

"That's been a founding principal at Atticus," Coburn said. "To combine knowledge of the structural and legal limitations of events, with a view of fundamental value."

Atticus has also branched out and now invests in all types of corporate events, but retains its focus on value investing.

The firm has generated impressive returns. The Atticus European fund was up almost 24% this year through the end of August. Last year, the fund gained more than 60% and has returned more than 27% a year since it started in 2001.

Performance like that in 2005 earned Barakett $200 million and the firm's vice chairman David Slager $150 million, making them among the 20 highest-paid hedge fund managers in the world, according to an annual survey by Alpha magazine. See full story.

Atticus is also a major player in some of the largest mergers and acquisitions currently sweeping the metals and mining industries. See full story.

When Mittal Steel
MT, +3.37%
the world's largest steel company, was struggling to acquire rival Arcelor (005786) earlier this year, Atticus wrote an open letter to Arcelor Chief Executive Guy Dolle urging him to meet with Mittal to discuss the offer.

At the time, Atticus was one of Arcelor's largest shareholders and owned 0.5% of Mittal.

More than five months later, Mittal announced that 92% of Arcelor shareholders had voted for its takeover. See full story.

Atticus was also instrumental in another metal industry deal, this time helping to derail a proposed $18 billion acquisition of nickel miner Inco Ltd.
N
by Phelps Dodge
PD, +1.90%

Atticus, which owns about 10% in the copper miner, argued for several months that Phelps Dodge shareholders would be best served if the company used big profits from the recent rally in copper to buy back its own stock -- or sell itself.

In early August, after Phelps Dodge pursued its buyout of Inco, Atticus upgraded its threat to soliciting proxies from shareholders.

But the firm never had to take the proxy route and, to some extent, got its way.

Earlier this month, Phelps Dodge and Inco said they terminated their planned union after Inco realized it was unlikely to receive enough shareholder votes needed to push the transaction through.

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